Trade tensions ease slightly on China move

WilliamL. Watts

WASHINGTON (MarketWatch) -- Trade-related anger has been running high on Capitol Hill, but may have been eased a bit by China's decision to let the yuan appreciate slightly against the U.S. dollar.

Assurances that China was set to ease the peg between the yuan and the dollar had already prompted Sens. Charles Schumer, D-N.Y., and Lindsey Graham, R-S.C., to delay a vote on legislation that would impose 27.5% punitive tariffs on Chinese goods until the end of the current legislative session.

Schumer on Thursday said the move to let the yuan appreciate 2% against the dollar wasn't big enough, but was an encouraging "baby step." As a result, Schumer and Graham said they would continue to hold fire in hopes further moves would be in the offing.

China's central bank announced Thursday that it had dropped the yuan-dollar link in favor of a peg tied to a basket of currencies. The government also lifted the value of the currency by more than 2% to 8.11 yuan per dollar.

Under the new system, the daily trading price of the dollar versus the yuan will continue to be allowed to float within a band of 0.3%, while the trading prices of non-U.S. dollar currencies will be allowed to move in yet-to-be announced bands. See full story.

Beijing's move effectively "takes the wind out of the sails" of the Schumer-Graham legislation, said Peter Kretzmer, senior economist at Bank of America.

Enthusiasm for such legislation has been fueled by ideas that the yuan's longstanding peg to the dollar has left the Chinese currency significantly undervalued, undermining U.S. firms on the world export markets.

Melissa Otto, an analyst with Decision Economics, agreed that the action would not only further dampen prospects for the Schumer-Graham legislation and any similar bills, but could also ease the prospect of further quotas on Chinese textile imports when existing quotas expire at the end of the year.

But it's unclear whether the move will give President Bush a leg up in his most pressing trade fight - achieving passage of the controversial Central American Free Trade Agreement.

Top House Republicans plan a vote on the pact next week, which would reduce trade barriers and tariffs between the United States, Honduras, Guatemala, Nicaragua, El Salvador, Costa Rica, and the Dominican Republic.

The Senate has approved the agreement, but proponents acknowledge that they remain short of needed votes on the House floor. Democrats are largely united in opposing the pact, and a large handful of Republicans from textile-, sugar- and manufacturing-heavy districts have signaled opposition to the pact, or are at least wavering.

House Ways and Means Committee Chairman Bill Thomas, R-Calif., agreed last week to back legislation sponsored by Rep. Phil English, R-Pa., that would increase scrutiny of China's trade practices, and open the door for expanding the use of retaliatory tariffs against Beijing.

Given Thomas's endorsement, English, who had opposed Cafta in a committee vote, promised to back the Cafta legislation on the floor, and said the move could prompt "four or five" other fence-sitters to also swing in favor of the trade pact.

Meanwhile, the House's top trade Democrat argued that the China move was too little.

"Most reliable estimates indicate that the yuan is undervalued by between 15 and 40%. China's action [Thursday] is estimated to be worth about 2%. China needs to implement a meaningful transition mechanism to a freely floating currency," said Rep. Ben Cardin of Maryland, the senior Democrat on the Ways and Means trade subcommittee.

House Democrats recently introduced legislation that also toughens scrutiny of China, and would give the Treasury Department more leeway to punish China for alleged currency manipulation.

For now, however, it appears likely China's move has successfully thwarted any major U.S. legislative action on the currency front, said Goldman Sachs economist Ed McKelvey. But he warned that pressure could rebuild.

"If this ends up being all or most of the move [by China], then legislators could resurrect some of the measures now being shelved," McKelvey said.

Meanwhile, one China expert said Thursday's move was only tangentially related to U.S. pressure.

China's central government had previously set 2010 as a date for establishing a liberalized foreign-exchange system," said Dan Rosen, a visiting fellow at the Institute for International Economics.

Beijing recognizes that China, in the meantime, could see some sort of economic downturn, said Rosen, who spoke at a forum Thursday at the American Enterprise Institute.

"The one time you don't want to revalue your currency is ... in a downturn," Rosen said.

Meanwhile, there are competing interest groups in China that were fighting over whether and how far to let the yuan appreciate, and in the end appear to have agreed to let the currency rise around 2% against the dollar.

"In terms of China instituting change, [Thursday's move] is a significant first step toward changes anticipated in the five years to come," Rosen said.

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